Great companies continue to increase their dividends during a downturn. To find these great companies, you will need to focus on more than just yield. You need to consider the stock's Free Cash Flow Payout. Free Cash Flow is Operating Cash Flow less normal capital expenditures (capital expenditures is usually the first line in the investing section). For a business to remain viable, it must replace capital assets when they wear out. That's why I prefer Free Cash Flow over Operating Cash Flow. Free Cash Flow tells you how much cash the company has left over after paying the normal operating expenses. This is the cash that is used to pay for acquisitions, debt obligations, and yes, dividends!
The formula for Free Cash Flow Payout is simply the Annual Dividend Per Share divided by Free Cash Flow Per Share. I like to see a percentage of 70% or less. The 70% is somewhat higher than many people look for with a traditional payout ratio. I am comfortable with the higher number since we are talking about real cash generated from running the business vs. accounting earnings that may or may not be there. This week I screened my database for select stocks with: - A free cash flow payout below 45% - A dividend yield over 3% The results are presented below...
Source: Dividend Growth Stocks
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